On the Defects of Mark-to-Market Accounting
Steve Ross explains some things to me:
- If you believe in organizational capital--in goodwill--in the value of the enterprise's skills, knowledge, and relationships as a source of future cash flows--than marking it to market as if that organizational capital had no value is the wrong thing to do.
- Especially as times in which asset values are disturbed and impaired are likely to be times when the value of that organizational capital is highest.
- If you believe in mean reversion in risk-adjusted asset values, mark-to-market accounting is the wrong thing to do.
- If you believe that transaction prices differ from risk-adjusted asset values--perhaps because transaction prices are of particular assets that are or are feared to be adversely selected and hence are not representative of the asset class--than mark-to-market accounting is the wrong thing to do.
- If you believe that changes in risk-adjusted asset values are unpredictable, but also believe:
- in time-varying required expected returns do to changing risk premia;
- that an entity's own cost of capital does not necessarily move one-for-one with the market's time-varying risk premia;
- then mark-to-market accounting is the wrong thing to do.
